Chapter 11: Problem 13

How do we measure a four-firm concentration ratio? What does a high measure mean about the extent of competition?

Short Answer

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A four-firm concentration ratio measures the market concentration by summing up the market shares of the top four firms in an industry. To calculate it, first gather market share data for all firms, identify the top four firms with the largest market shares, and then sum up their market shares. The formula is: Four-Firm Concentration Ratio = \( \frac{Market\ Share\ of\ Firm\ 1 + Market\ Share\ of\ Firm\ 2 + Market\ Share\ of\ Firm\ 3 + Market\ Share\ of\ Firm\ 4}{Total\ Market\ Share} \) x 100% A high measure (above 80%) indicates an oligopolistic market structure and less competition, while a lower concentration ratio (below 50%) suggests a more competitive market with a larger number of smaller firms.

Step by step solution

Definition of Four-Firm Concentration Ratio

A four-firm concentration ratio is an indicator used to measure the degree of market concentration by summing up the market shares of the top four firms in an industry. A higher four-firm concentration ratio signifies that these four firms have greater control over the market, while a lower ratio indicates a more competitive and dispersed market.

Gather market share data

To calculate the four-firm concentration ratio, first gather the market share data for all firms in the industry. Market share data can be obtained from various sources like government databases, industry reports, or other reliable data sources.

Identify the top four firms

After gathering the market share data for all firms, identify the top four firms with the largest market shares in the industry.

Calculate the four-firm concentration ratio

Sum up the market shares of the top four firms. The resulting number will be the four-firm concentration ratio of the industry, expressed as a percentage. The formula to calculate the four-firm concentration ratio is: Four-Firm Concentration Ratio = \( \frac{Market\ Share\ of\ Firm\ 1 + Market\ Share\ of\ Firm\ 2 + Market\ Share\ of\ Firm\ 3 + Market\ Share\ of\ Firm\ 4}{Total\ Market\ Share} \) x 100%

Interpretation of the concentration ratio

A concentration ratio is usually measured on a scale of 0 to 100%. A higher measure, typically close to or above 80%, could indicate an oligopolistic market structure, where a few large firms dominate the market. This could suggest less competition in the market, leading to potentially higher prices and barriers to entry for other firms. Conversely, a lower concentration ratio (below 50%) would suggest a more competitive market with a larger number of smaller firms, leading to more competitive pricing and fewer barriers to entry for new competitors.